Warning: State Income Tax

Taylor Lee Blog

By: Braxton Parish, MSAT

In the e-commerce environment the term Wayfair (South Dakota v. Wayfair 17-494, 2018) is becoming more and more common. It’s no secret this iconic case has completely altered the sales tax landscape. However through this case, the Supreme Court case has done more than tighten rules around sales tax, it has also quietly opened the door to a topic that has likely flown under the radar of many online seller’s; state income tax.

Trying to keep taxation rules straight for all 50 states is a very overwhelming task for most everyone. A majority of sellers assume if the home state’s income tax return is filed, then the full compliance box can be checked. However, that is not always the case. What most people likely aren’t aware of is there are rules that can cause the business or individual to be subject to income tax in multiple states. This fact triggers several questions a business should consider. Is income tax nexus and sales tax nexus the same? Don’t you have to have a physical connection to the state? Can you be relieved of state income tax if you never actually set foot in the state? The answer, as with most state and local tax issues: it depends on the state. This is where the Interstate Income Act of 1959, also known as Public Law 86-272 (P.L. 86-272), helps provide some clarity.

Wrigley & P.L. 86-272, why does it matter?

Up until the passage of P.L. 86-272 states were able to impose income tax on any taxpayer with any type of physical connection to the state. However, the burden placed on taxpayers from trying to comply with such volume of different rules was far too much to ask. After outcries from the business community Congress was forced to act and passed P.L. 86-272. This law essentially establishes that no state, or political subdivision thereof, can impose a net income tax on the income derived within a state by any person from interstate commerce if the only business activities within the state are the solicitation of orders for sales of tangible personal property. When those orders are sent outside of the state to be approved and are filled by shipment or delivery from a point outside the state. Furthermore, the law states “a person shall not be considered to have engaged in business activities within a state during any taxable year merely by reason of sales in such state.” (15 U.S.C § 381(c))

In 1992 the Supreme Court took a closer look at what the phrase “solicitation of orders” really means. Based on their decision in Wrigley (Wisconsin Dept. of Revenue v. Wrigley 112 S.Ct. 2447) we now know “solicitation of orders” covers those activities that are entirely ancillary to requests for purchases, or in simpler terms, activities that do not serve a business purpose aside from generating sales requests from customers inside the state. In the context of e-commerce sellers, one of the most important components to come from the Wrigley case is the fact that having inventory in the state is not ancillary to the solicitation of orders and therefore can create income tax nexus. Meaning if a seller has inventory fulfilled by an out-of-state 3PL or Amazon’s FBA system, they very well may be subjected to multiple state jurisdictions for income tax. Each state has their own complexities and, to minimize risk, it’s critical for businesses to evaluate all their business activities in each state every year and understand where they stand. It is also encouraged to consult with a tax professional to determine in which state it makes sense for them to file an income tax return.

What exactly should I know about State Income Taxes?

In the most general sense, like federal income tax, state income taxes are determined by calculating gross receipts minus deductions with the result being taxable income. However, it’s important to be aware some states impose taxes that are not measured by income. Some of the most common examples are the Ohio Commercial Activity Tax, the Texas Franchise Tax, and the Washington Business and Occupation tax. These taxes are not measured by the net income but by the business generated in the state and as such, the protection offered by P.L. 86-272 does not extend to these taxes.

Why is this important?

Nexus, interstate commerce, court cases… this stuff is complicated! Working with e-commerce sellers across the world,  many sellers aren’t aware the risk state income tax can pose when running or deciding to start an e-commerce business. The reality is ignorance of state rules as it relates to e-commerce can certainly haunt a business if not addressed and, as with most laws, will not be accepted as an excuse for noncompliance. Not only is complying with state tax laws important from a tax perspective, but it is also important when listing or purchasing an e-commerce business. Any buyer completing necessary due diligence could, and should, ask if a listed e-commerce business is compliant with both income tax and sales tax laws for all jurisdictions it operates in. It’s extremely important to fully understand the risks involved. For more information about how these issues apply to your business, please visit Click & Mortar Accounting and schedule time to evaluate strategic options as it relates to state tax concerns.

About Click & Mortar Accounting

Click and Mortar Accounting caters bookkeeping and tax services to E-commerce and Amazon FBA Sellers. We work virtually, providing you access to timely information that will allow you to effectively run your business. Our professionals have many years of bookkeeping and tax experience. Simply put, you sell stuff online, and we help you account for it.